Can Middle East stock markets recover their strength?

Middle East stock markets present a curious spectacle of decline at a time of super-strong oil prices. The IMF, for example, has just described the UAE as one of the fastest growing economies in the world - with 14% GDP growth predicted for 2006 - and yet the UAE stock market is down 40% this year.

Saudi Arabia has the biggest oil surplus in history in prospect this year, but its stock market has tumbled 50%. Perhaps then a strong rally was to be expected. The question is whether this rally can be sustained or proves to be a selling opportunity.

Benjamin Graham, the guru who taught Warren Buffett, used to use the analogy of Mr. Market, the manic depressive. On certain days Mr. Market was wildly over-optimistic, and on other days he was terribly depressed. Usually there was some reason for this violent mood swing but they always got exaggerated by Mr. Market.

Mood swings

So in the context of the Middle East, why is it that Mr. Market was so optimistic last year, and has fallen apart in 2006? The fundamentals have hardly changed, with oil prices high and investment-led growth powering ahead.

The problem is more with Mr. Market than the economics. Having got carried away with a wave of enthusiasm last year - driving share prices to unsustainably high levels - share prices looked too expensive. Hence the sudden panic attack and the rush to exit the market. Terrorism and Iran are hardly new factors.

Indeed, having sent share prices too high last year, this year share prices may have gone too low. For the oil price is not just high but on a rising curve, and governments have not abandoned their investment plans - for from it, everyday brings a new mega-project.

Market nerves

So can Mr. Market recover his nerve? Well, in real life things are a bit more complicated than that. Small investors who have lost money will not be able to re-enter the market unless banks lend money to them again, which is not likely, especially if earlier loans remain outstanding. They will also be chastened by experience.

This assumes that there is no banking crisis to follow the current dramas in the stock markets of the Middle East. For the volume of borrowed money that has been lost in the market mayhem will have to be accounted for in some bank's balance sheet, and this may have created a hole too big to carry in some cases.

The most likely scenario is that Mr. Market will take a holiday and having tested a market bottom hover around that level until something, good or bad, turns up. Certainly a repeat of the madness of crowds seen in 2005 is highly unlikely, and while Mr. Market may recover his spirits a little, his overconfidence will now be held in check.